Picking the Right Business Structure for your Start Up
In launching your venture, it’s important to pick the right business structure. Choosing the wrong business structure may have tax implications, limit your ability to bring on a partner or may expose you to unnecessary liability and risk. The business structure is the foundation of your business and it’s important to get it right. Below is a primer on the various types of business structures under which you could operate.
A sole proprietor is a for profit business that is operated by one owner. There are many advantages to operating as a sole proprietor, which include the following:
The owner owns all assets and profits of the business;
Minimal legal requirements to maintain; and
No separate tax records required.
However, there are several disadvantages to operating under a sole proprietorship, Oftentimes, the disadvantages outweigh the advantages, especially as your business grows. Examples include:
Unlimited personal liability for the owner; and
The owner is personally liable for all debts and obligations of the business.
Ultimately, there is no distinction in law between the assets, liabilities, profits and expenses of the business and the sole proprietor. If the business is sued, all personal assets of the sole proprietor, regardless of whether the assets are a part of the business or not, are open to attack. For this reason alone, operating under a sole proprietorship carries significant risk. Sole proprietorships are not ideal for those businesses where there is a significant degree of risk and/or where the owner has already amassed personal assets that it wishes to separate from the business.
Some business owners wish to commence as a sole proprietorship and then eventually evolve to an incorporation, once the business has scaled to a certain level. It is always possible to make this transition. However, be cognizant that there are some administrative matters to address in this transition, which we itemize below:
Provide adequate notice to customers, suppliers and other relevant third party businesses;
All debts and obligations must be assigned to the incorporation;
All ongoing contracts must be assigned to the incorporation; and
All business records, invoices and other documents must be maintained under the incorporation.
A partnership is a for profit business operated by more than 1 person. A general partnership is where each of the partners are actively (and for the most part equally) involved in the business. A limited liability partnership can only be formed for the purpose of practicing a profession that specifically allows for the formation of a limited liability partnership, such as law and accounting. A limited partnership is variation of a general partnership, whereby one of the partners is significantly less involved in the business. The partnership would be comprised of a general partner and a limited partner.
A key component of a partnership is that the partners owe a fiduciary duty to the partnership and also to one another, which encompasses a duty of loyalty and a duty to avoid conflicts of interest.
There are advantages and disadvantages of entering into a partnership. Here are some of the advantages:
A potentially larger pool of investment;
Sharing of financial and legal risk; and
Sharing talent and responsibilities between partners.
Here are some of the key disadvantages:
Unlimited personal liability;
Joint and several liability; and
Vicarious liability for the acts and omissions of the other partners.
Regardless of whichever type of partnership you are operating under, the partner should enter into an agreement that sets out the rights, duties and responsibilities of each partner.
A corporation is a separate legal entity. It has the capacity to enter into legally binding relationships, to sue and to be sued. Technically, the corporation is owned by the shareholders. A corporation can be federally or provincially incorporated. It can operate under a numbered company or as a named company.
Overall, incorporations are a preferred business entity from which to operate your business. Here are some of the advantages to operating your business under a corporation:
The owners have limited liability;
A corporation never dies and can survive those operating the corporation; and
There can be tax advantages to operating as a corporation.
Although the limitation of liability is a huge pro for incorporations, there are some disadvantages, such as
There is a greater (although not significant) cost to incorporating, as opposed to operating as a sole proprietor or partnership;
There is a greater (although not significant) administrative obligation to incorporate and maintain the corporation.
There are three key corporate groups of players that are involved in a corporation:
Directors manage and/or supervise the management of the business and affairs of the corporation. There are certain requirements that must be met in order to qualify to be a director, including the director must be over 18 years old, of sound mind, an individual and not bankrupt. There is also a Canadian residency requirement to be a director. At least 25% of the directors must be Canadian.
Officers comprise the senior management of the corporation. Officers are appointed by the directors of the corporation. The officers implement the strategic decisions of the corporation and manage the business and affairs of the corporation. Officers hire and manage employees and perform the daily activities involved in managing a business.
Shareholders are essentially owners of the corporation. They are individuals that invest into the corporation and own shares, which provides them with rights to the corporation. Generally, shareholders do not make business decisions for the corporation and their ability to affect the financial direction of the company is limited.
The Articles of Incorporation is the document that creates the corporation. The minute book is comprised of key documents that are mandatory and that govern how the corporation is structured and run. It includes the Articles of Incorporation, by-laws, resolutions, registers, ledgers. It is mandatory to maintain an accurate record of these documents.